FDIC Law, Regulations, Related Acts

4000 - Advisory Opinions

Classification of Loan as Insider Loan Does Not
Cause Loan to Be in Violation of Regulation O

FDIC-81-10

April 7, 1981

Pamela E. F. LeCren, Attorney

The following is in response to your March 27, 1981 letter
requesting an opinion from the Legal Division regarding (1) whether or
not the classification of an insider loan in and of itself causes the
insider loan to be in violation of Federal Reserve Board Regulation O
(12 C.F.R. Part 215) and (2) what if anything can a bank do in terms of
a workout arrangement with regard to an insider loan when that loan has
been classified.

According to your letter, *** has had a longstanding credit
relationship with ***, a vegetable canning company. (Although your
letter does not specifically state, we will presume that *** is a
related interest of one of the bank's insiders.) During the bank's last
examination an outstanding loan to *** was classified substandard.
According to your letter, the subject loan when extended was made on
substantially the same terms, including interest rate and collateral,
as those prevailing at the time for comparable transactions with
persons not employed by the bank nor subject to Regulation O.
Furthermore, the loan did not present a more than normal risk of
repayment or other unfavorable
features.1

The bank did not renew the loan due to concerns regarding Regulation
O. Rather than being renewed it was continued and a loan restructuring
proposal reviewed. Part of the restructuring proposal called for the
bank to lower its dollar exposure, maintenance of an existing accounts
receivable and inventory formula, permitting temporary periods in which
the loan would be "out" of formula, and substantial reduction of
the loan over a set period of time.2
The bank's executive committee deferred action on the proposal pending
an assessment of the implications of Regulation O.

The Legal Division is of the opinion that the mere classification of
an insider loan does not indicate a violation of Regulation O
(specifically § 215.4(a) on preferential lending) under the
circumstances posed by your letter. Furthermore, Regulation O does not,
in our opinion, require the bank to immediately call an insider loan
that has been classified. If that loan is subsequently renewed or
handled in any manner which creates a new extension of credit as that
term is defined in § 215.3 of Regulation O, the bank may find itself
in violation of § 215.4(a) if in so renewing or handling the loan the
bank is not treating the insider loan as it would treat a similar
non-insider loan. In short, if the bank in administering a workout of a
distressed insider loan takes the same steps that it would take with
reference to any other distressed loan of like type and amount and the
insider loan is not given some preference in the manner in which it is
handled, there would be no violation of § 215.4(a). Whether or not
such a violation exists is a fact question and the bank should be
prepared to substantiate any claim of non-preferential treatment. We
are not now in a position to indicate whether or not the specific steps
you propose in your letter to possibly be implemented in a workout of
the loan would or would not present a problem under § 215.4(a).
Assuming that the steps you outline conform to existing written or
unwritten policies regarding loan workouts it is not likely that we
would find a Regulation O violation.

We hope that this letter has been responsive to your
questions.

1 The Legal Division has had little occasion to define the
phrase "other unfavorable features". Suffice it to say that we
are presently of the opinion that what is encompassed by that phrase
must be determined on a case-by-case basis. We will assume that no
unfavorable features were associated with the *** *** loan at the time
of its extension i.e. it was a prudent business loan fully conforming
in all respects with sound banking practice. Go back to Text

2 You indicated during a meeting in my office on March 25, 1981
that the loan has already been substantially reduced and that, as
reflected in your letter, the bank had taken additional collateral on
the loan prior to its classification. It is the bank's opinion that the
bank would be adequately protected by the additional collateral during
any period of time in which the loan was "out" of formula. Go back to Text